Seeking Alpha

Living4Dividends'  Instablog

Living4Dividends
Send Message
Living4Dividends is an individual investor.
  • The Correlation Between Dividends and Return on Equity - by: David Templeton May 19, 2009 6 comments
    May 21, 2009 7:58 AM

    Schwab moved / deleted this from their website so I glad David Templeton archived this articleThe Correlation Between Dividends and Return on Equity
    by: David Templeton May 19, 2009    
    One certainty in this market is dividend paying companies are finding it palatable to cut their payout to investors.
     
     
    Click to enlarge:
    graph of number of companies cutting dividendCharles Schwab & Co. (SCHW) recently issued a research report that evaluated a number of different financial factors and found companies that have higher ROE's (return on equity) are less likely to cut their dividend. Schwab reviewed the characteristics of dividend-paying stocks within the top 3,200 stocks by market capitalization, from 1990 through February 2009.

    The result of the research noted:

    • A firm with high ROE is more likely to be able to generate income in excess of expenses and, thus, support its dividend.
    • To examine ROE’s ability to predict future dividend changes, SCHW calculated each dividend-paying stock’s trailing 12-month ROE at the end of each month from 1990 to February 2009. They then calculated each stock’s subsequent 12-month change in dividends at the end of each month, and used this change number to split their dividend-paying universe into three groups: those that cut dividends, those that raised them and stocks with no change. Then, they examined the success of ROE in identifying safer dividend payers.
    • What they found was stocks in the lowest 20% of ROE were twice as likely, on average, to cut dividends as the other 80% over the subsequent 12 months, as noted on the below chart.

    Click to enlarge:

    percent of stocks that cut dividendThey also found that companies with a high ROE had more dividend increases.
    • Stocks in the top 20% of ROE increased dividends, on average, more than 60% of the time during the subsequent 12 months, as the chart below details.

    Click to enlarge:

    percent of stocks that raised dividendIn the end, the research concluded, "investors could have minimized their risk of experiencing a dividend cut by focusing on dividend payers with higher ROE." They also found the higher ROE dividend payers had higher total returns compared to the dividend paying universe of 3,200 stocks.

    Lastly, I recently wrote a post noting how ROE is a component of the dividend discount model (*DDM)). Although the dividend discount model may seem simplistic, when looking at the variables that are at play in this model, an investor will get a better understanding of the financial factors behind the DDM.

    Source: Are Your Stock Dividends Safe? Charles Schwab & Co.

Back To Living4Dividends' Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (6)
Track new comments
  • Living4Dividends
    , contributor
    Comments (1220) | Send Message
     
    Author’s reply » Schwab moved / deleted this from their website so I glad David Templeton archived this article
    21 May 2009, 07:43 PM Reply Like
  • TLassen
    , contributor
    Comments (198) | Send Message
     
    thanks for the article Liv$divs.
    Isn't it logical that companies with lower ROE's are more likely to cut their dividends? Let's remember the ROE ratio has two factors, increase in Net Income and/or increase in the liability side (assuming more debt)
    As dividends are paid from profits it is not surprising the correlation between the lower ROE and dividend cuts, or mybe I missed the point completely.
    As a good indicator for a company's ability to sustain or increase it's dividends, find the dividend payout ratio by dividing the total dividends paid into Free Cash Flow rather than Net Income. (Net income is easier to manipulate that the FCF) I look for less than 40% Dividend payout ratio as an indicator of safe dividends.
    22 May 2009, 12:35 PM Reply Like
  • Living4Dividends
    , contributor
    Comments (1220) | Send Message
     
    Author’s reply » I question the usefulness of Schwab's study.

     

    Instead of paying higher dividend, if a company buys back it's own shares, it increases it's ROE. This article says that companies with high ROEs do not cut their dividends. What Schwab did not mention, is do these dividend payors pay any meaningful (high) dividends?

     

    I'll give you a better example of "non dividend cutters" How about companies that pay measly dividends (1%) ? They are far less likely to cut their dividends. And because they buy back their own shares, they have higher ROEs. However these meager dividend payors are not suitable for an income investor.

     

    I like your idea of FCF as an indicator of safe dividends. Have you seen any studies that confirm this?
    26 May 2009, 08:57 PM Reply Like
  • TLassen
    , contributor
    Comments (198) | Send Message
     
    not any studies really to support that, but if we think logically, dividends are paid from cash during the cycle. I believe it is generally accepted that Net Income is easier manipulated as supposed to Free Cash Flow (Cash from Operations less Cap Ex). For sure it's a better measurement of a company's profits than Net earnings because a company can show positive net earnings (on the income statement) and still not be able to pay its debts or have adequate coverage for dividends.

     

    Here is a good link, written by Ben McClure, www.investopedia.com/a...

     

    I agree with you questioning Schwab's study, maybe that's why it was pulled that quickly....:)
    27 May 2009, 06:31 PM Reply Like
  • Tom Au, CFA
    , contributor
    Comments (6780) | Send Message
     
    It's really about ROEs. The higher the ROE, the "more" (realative to book value) there is to pay dividends--or finance growth (or do both).
    10 Jun 2009, 10:36 AM Reply Like
  • Living4Dividends
    , contributor
    Comments (1220) | Send Message
     
    Author’s reply » I tend to side with Tlassen - Because dividends are a flow of cash to the investor - I think a better sign is cash flow - or free cash flow - these are a lot harder to fudge.

     

    On Jun 10 10:36 AM Graham and Dodd Investor wrote:

     

    > It's really about ROEs. The higher the ROE, the "more" (realative
    > to book value) there is to pay dividends--or finance growth (or do
    > both).
    18 Jun 2009, 08:37 PM Reply Like
Full index of posts »
Latest Followers

StockTalks

  • GBP/USD 1.6473
    Dec 6, 2009
  • EUR/USD 1.4872 + 0.0015
    Dec 6, 2009
  • Dow 10,388.90 +22.75 +0.22%
    Dec 6, 2009
More »

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.